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Chapter 8: Problem 15

A sales tax of 10 percent is placed on half the firms (the polluters) in a competitive industry. The revenue is paid to the remaining firms (the nonpolluters) as a 10 percent subsidy on the value of output sold. a. Assuming that all firms have identical constant long-run average costs before the sales tax-subsidy policy, what do you expect to happen (in both the short run and the long run), to the price of the product, the output of firms, and industry output? (Hint: How does price relate to industry input?) b. Can such a policy always be achieved with a balanced budget in which tax revenues are equal to subsidy payments? Why or why not? Explain.

Short Answer

Expert verified
The new policy will result in short-term increase in prices due to increased costs for the polluting firms; however, these could decrease in the long run thanks to competition and cost reduction strategies. Industry output might increase overall due to the cost advantages experienced by the non-polluting firms. A balanced budget is feasible under these conditions, however, it could become difficult if the relative output of polluting and non-polluting firms changes significantly.

Step by step solution

01

Analyze the impact of sales tax on polluting firms

With the new tax and the assumption of identical constant long-run average costs, the taxed firms will see an increase in their production costs by 10 percent. This might lead to a decrease in their output in an attempt to minimize the increased costs. In the short run, the firms can pass on part of this tax to consumers by increasing the price. However, in a competitive market, this might be difficult to maintain in the long run and these firms might consider ways to reduce pollution or cost of production.
02

Analyze the effect of a subsidy on non-polluting firms

The non-polluting firms benefit from the implemented policy by receiving a 10% subsidy, effectively reducing their production costs and allowing them to possibly increase their output or lower their prices to gain a larger market share. In both the short and long run, these firms could potentially expand production and increase overall industry output.
03

Analyze the impact on the price of the product

In the short run, the overall price of the products may increase due to the cost incurred from the tax by the polluting firms. But in the long run, the decreased cost of production from the non-polluting firms and increased competition could potentially cause the prices to stabilize or even decrease.
04

Evaluate the feasibility of a balanced budget

A balanced budget where tax revenues equal subsidy payments can be achieved if the number of polluting and non-polluting firms are identical and all firms have a similar output, as has been assumed in this exercise. However, if the output of either of these types of firms changes significantly, maintaining a balanced budget could become challenging.

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Most popular questions from this chapter

Suppose you are given the following information about a particular industry: \\[ \begin{array}{ll} Q^{D}=6500-100 P & \text { Market demand } \\ Q^{S}=1200 P & \text { Market supply } \end{array} \\] \\[ C(q)=722+\frac{q^{2}}{200} \quad \text { Firm total cost function } \\] \\[ M C(q)=\frac{2 q}{200} \quad \text { Firm marginal cost function } \\] Assume that all firms are identical and that the market is characterized by perfect competition. a. Find the equilibrium price, the equilibrium quantity, the output supplied by the firm, and the profit of each firm. b. Would you expect to see entry into or exit from the industry in the long run? Explain. What effect will entry or exit have on market equilibrium? c. What is the lowest price at which each firm would sell its output in the long run? Is profit positive, negative, or zero at this price? Explain. d. What is the lowest price at which each firm would sell its output in the short run? Is profit positive, negative, or zero at this price? Explain.

Suppose you are the manager of a watchmaking firm operating in a competitive market. Your cost of production is given by \(C=200+2 q^{2}\), where \(q\) is the level of output and \(C\) is total cost. (The marginal cost of production is \(4 q ;\) the fixed cost is \(\$ 200 .\) ) a. If the price of watches is \(\$ 100,\) how many watches should you produce to maximize profit? b. What will the profit level be? c. At what minimum price will the firm produce a positive output?

A sales tax of \(\$ 1\) per unit of output is placed on a particular firm whose product sells for \(\$ 5\) in a competitive industry with many firms. a. How will this tax affect the cost curves for the firm? b. What will happen to the firm's price, output, and profit? c. Will there be entry or exit in the industry?

Suppose that a competitive firm has a total cost function \(C(q)=450+15 q+2 q^{2}\) and a marginal cost function \(M C(q)=15+4 q .\) If the market price is \(P=\$ 115\) per unit, find the level of output produced by the firm. Find the level of profit and the level of producer surplus.

Suppose that a competitive firm's marginal cost of producing output \(q\) is given by \(\mathrm{MC}(q)=3+2 q\). Assume that the market price of the firm's product is \(\$ 9\) a. What level of output will the firm produce? b. What is the firm's producer surplus? c. Suppose that the average variable cost of the firm is given by \(\mathrm{AVC}(q)=3+q .\) Suppose that the firm's fixed costs are known to be \(\$ 3 .\) Will the firm be earning a positive, negative, or zero profit in the short run?
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